What is a technology company?

It became impossible to ignore the market’s dubious definition of a 'technology' company when WeWork tried to IPO two years ago. How could a business that rented out desk space, with losses of $1.6bn on revenues of $1.8bn, be a tech stock that warranted a $47bn market cap? Pundits bickered until the flotation was eventually shelved, and briefly put the issue of questionable 'tech' companies out of sight. 

But the issue is crawling back into the mainstream. Not least in the shape of Deliveroo (ROO), the food delivery app whose flotation on the LSE flopped earlier this year. It joins a growing list of businesses that are billing themselves as tech companies, reaping hyped valuations and drawing in a flurry of new retail investors chasing the next tech megatrend. 

This is not without precedent. During the dotcom bubble of the late 1990s to the early 2000s, when US internet-based companies saw their valuations soar and then plummet, value was almost immediately attached to businesses that simply stitched the phrase ‘dotcom’ to the end of their names. 

Two decades later, and there is still no one stopping companies from masquerading as tech businesses. In fact, it is arguably being encouraged by our government. Chancellor Rishi Sunak personally endorsed Deliveroo’s IPO, with a neat statement next to the company’s announcement that it was considering floating in London back in March: “It's fantastic that Deliveroo has taken this decision to list on the London Stock Exchange…[it] has created thousands of jobs and is a true British tech success story.” 

Like any savvy politician, Sunak did not offer his public support for no reason. He has a vested interest in Deliveroo’s success: it is the first company to have listed on the back of a Treasury-commissioned review designed to attract more ‘tech’ businesses, with looser controls on tiered-rights structures. Biotech business Oxford Nanopore – another company whose tech title is arguably questionable – quickly followed suit. In the US, it looks like WeWork is taking a second run at an IPO through a special purpose acquisition company (SPAC). 

But the problem does not lie solely with governments, or with investors. The industry itself has opened up its virtual gates, so that any number of bright, tech-enabled ideas are regularly greeted with huge funding rounds and Silicon Valley lingo. The UK’s own sector network, Tech Nation (which is also government-backed), offered in 2017 what we think is a flawed definition of a tech company: “A business that provides a digital technical service/product/platform/hardware, or heavily relies on it, as its primary revenue source.” 

It is the “heavily relies on it” part that we dispute, and often lies at the root of what is making it harder for investors to separate the wheat from the chaff in the tech sector. In this feature, we will outline why a number of the industry’s hottest names are tech-enabled at best, rather than tech companies themselves, and then offer an alternative way to judge their respective market positions. 

Businesses that use but do not sell tech 

We do not think that all companies that use – although, importantly, do not sell tech – should be counted as tech businesses. These outliers can be grouped loosely into three categories: connectors, entertainers and retailers.

Connectors

Thanks to national lockdowns, food delivery looks like the tech industry’s flavour of the month – or, rather, year. Restaurant closures have spurred huge revenue growth for these businesses, and excitement over their growth potential has pushed several stocks to new heights. In the UK, Amazon-backed (US:AMZN) Deliveroo (ROO) debuted on the London Stock Exchange at a market capitalisation of £7.6bn, almost double its 2019 price tag reported between $3bn and $4bn. That IPO famously flopped – but its rival Just Eat Takeaway.com (JET) still looms large in the UK’s listed ‘tech’ sector, with a market value of £10.3bn. Meanwhile, Asian peer Grab is set for a massive $39bn IPO in the US. 

But these are not tech companies. They are delivery businesses, with an app that connects consumers to a third-party service. The same could be said of Uber’s (US:UBER) taxi service, or even Airbnb’s (US:ABNB) marketplace for homestays. 

They are tech-enabled. This means that a large chunk – if not most – of these companies’ research and development efforts and capital expenditure are directed towards their respective digital platforms. And in fiercely competitive, young markets, the quality of these companies’ apps is extremely important, given that it is a face of their product. The tech is more complicated than just app building – the companies’ services are often supported by complex machine learning algorithms that improve the efficiency of their marketplaces. 

But that is not enough to make them a tech company. ‘Pure’ tech companies are the enablers: they are hardware and software businesses. If Deliveroo sold solely the software that currently supports its delivery network, that would make it a tech company. It would generate value from its proprietary tech, by selling it onto logistics businesses. But the company’s mix means that it does not enjoy all the benefits of a software stock in its model, such as big, recurring contracts and the ability to scale at pace.  

“Food delivery, ride sharing, ride logistics: it is more about utilising technology,” says David Older, head of equities at Carmignac. “The only reason they exist is because of the invention of the smartphone.” 

These companies are usually burdened with the costs that come with operating in the industry of their third-party providers. Worker rights is chief among them. In England, Uber was pushed to accept their drivers as full-time employees, giving them the right to the national minimum wage, pension contributions and holiday pay equivalent to 12 per cent of their compensation. Concerns over worker rights contributed to Deliveroo’s drop – another sign that the market is struggling to make sense of the tech narrative that these companies are spinning, versus the reality of their business models. 

Airbnb too had a rocky start in its first few months as a public company last year, as the pandemic wiped out international travel, proving again that the so-called ‘tech’ company’s connection with the health of the travel and leisure industry is inextricable. And here too management was thrust into choppy waters with its third-party providers – in this case, ‘hosts’, – who were badly hurt by enforced pandemic refunds. Now there are reports that a rising number of hosts are advertising on Airbnb’s marketplace to lure users into booking their properties privately. 

Entertainers 

The line between tech companies and entertainment companies is a blurry one. Take Netflix (US:NFLX), which is lumped rather lazily in the ‘FANMAG’ group (Facebook, Apple, Microsoft, Amazon and Google). Chief executive Reed Hastings quibbled with the word “media'' in an interview with CNBC last year. He asserted that Netflix was best defined as an “entertainment” company: “Tech, I mean, we’re tech-powered, but we’re not really like Microsoft, that’s in multiple areas of tech, or Google,” he said. “We have more employees in Hollywood than we do in Silicon Valley. Two-thirds of our spending is on content. So we’re really an entertainment company.”

UK-listed games developer, Sumo (SUMO), has a similar approach. “I’ve always described us as an interactive entertainment business,” says chief executive Carl Cavers. ““We use...very sophisticated tech and we need very skilled people to do it. But it is just part of how we facilitate our games to market.”

Both Netflix and video game developers depend largely on organic content creation to drive results. For third-party intellectual property, Netflix, like traditional broadcasters, must battle it out for the right to air programmes it does not own. In fact, while Netflix captured massive growth during the pandemic, with subscribers passing the 200m milestone for the first time, it also faced some of the challenges that traditional TV companies dealt with last year. That includes serious delays to production, splintering viewership, and competing for attention online as short-form video apps rocketed. 

Netflix’s tech-based streaming model kickstarted the next generation of media consumption, but it is media consumption all the same. As more invest in original content to differentiate themselves from their peers, they are beginning to look more like traditional broadcasters. This might go some way to explaining why Hastings is so eager to move away from his company’s tech label – Netflix looks better against the likes of CBS than it does against Google’s YouTube. 

Retailers

The most glaring group of businesses that bill themselves as tech: retailers. Moonpig (MOON) floated early this year, dressing itself up as a tech company by pointing to their investment in software and data analytics. The word “technology” appeared 76 times in its prospectus. “Retail” was behind at 66. 

True that the company does not have any physical shops – and the temporary closure of high street rivals during lockdowns has helped to cement its position in the greeting cards market. But both WH Smith’s (SMWH) ‘Funky Pigeon’ cards business and Card Factory (CARD) have fast-growing online services, too – and a change in consumer behaviour online has pushed them to modernise faster. Card Factory launched a new website last summer, and invested in the migration of its ‘gettingpersonal.co.uk’ brand onto the ‘cardfactory.co.uk’ platform. Its tech is less advanced than Moonpig’s – but if management chose to ditch its high street presence and pivot to an online-only approach, it could use the cash to develop underlying technology that is equally as competitive. 

To be clear: that is not Card Factory’s strategy at the moment. But retailers challenged by digitally-native businesses will eventually have to deploy significant resources on their own online services if they want to survive. The early adoption of tech is doubtless a competitive advantage – but eventually its application will be omnipresent. Using it to define what makes a tech company will become meaningless in the long run. 

Red herrings 

This leads us onto one of the greatest red herrings in identifying a tech business: tech-based expenditure. So-called ‘disruptive’ companies that use new tech as a competitive advantage naturally pour lots of money into its development. In 2020, Uber’s R&D spending was worth a fifth of the company’s revenues, which it said consisted primarily of compensation costs for staff in engineering, design and product development.

But Uber and its ‘disruptive’ peers are not the only ones. Take retail giant Walmart (US:WMT) – it spends just over half of its total capital expenditure on its (admittedly wide) “e-commerce, technology, supply chain and other” category. That includes developing Walmart+, its membership programme that it hopes could rival Amazon Prime. In the UK, Marks and Spencer (MKS) said that its IT and website was its second biggest allocation of capital expenditure in 2020, not far behind property asset replacement 

Neither Walmart nor Marks and Spencer, obviously, are tech companies – and they do not try to masquerade as such. In short: a big tech department does not make a tech company. Both Moonpig and Airbnb boasted the number of engineers they employed in their respective prospectuses – but a LinkedIn study from 2018  found that ‘software developer’ had climbed up to the third most popular job title in retail, up from eighth in 2013. Investing in tech is not sector specific, it is the recipe for long-term success in almost every corner of the market.  

“The primary investment for any company is digitsation, creation, software investment,” says Older. “So it's just table stakes for a company in the world today.” 

So, what should a tech company look like? 

Seasoned tech investors will already know the glee of finding a well-run, pure software-as-a-service (‘SaaS’) business. That includes the likes of Adobe (US:ADBE), Salesforce (US:CRM) and Zoom (US:ZM) – companies that charge their clients on an ongoing basis for access to their proprietary technology. These businesses, if managed well, typically have a high proportion of recurring revenue, high margins and plenty of cash. 

Of course, not all tech businesses have the same profile. Hardware companies – including chip-makers – have much higher operating costs, as they oversee huge manufacturing sites. And the lines between other industries are not always clear-cut: three years ago, the US stock market officially reclassified Google and Facebook as “communication services”, rather than technology. 

Both companies generate the bulk of their revenue from advertising sales. William de Gale, fund manager at Bluebox Global Technology, thinks that this makes them more akin to media businesses. “The bankers love calling things tech stocks because they get another five times sales on the multiple,” he says. “But in the end, these are actually businesses selling to people and not selling technology.”

But Google and Facebook’s first-mover advantage in their respective markets meant that they secured an early dominant position and the ability to fund technological research elsewhere. This has made them industry leaders in markets outside of their core businesses, including artificial intelligence (AI), augmented reality (AR) and cloud computing. Google Cloud, for example, is a pure tech business by itself, although it accounts for only 7 per cent of the group’s total revenue. 

This leads us to the wider group of businesses that sell software, but do not generate most of their profits from it. Take Ocado (OCDO), which only started to call itself a tech company two years ago, when it pushed its proprietary software, Ocado Smart Platform (OSP), out from its background operations to the fore. Its market value has more than doubled since – and now, according to some, it is one of London’s largest listed tech companies. But most of its sales still come from its joint delivery business with Marks and Spencer, which straddles the more complex worlds of logistics and retail. 

That business is doing well – its most recent update showed that revenues were up two-fifths to £599m in the 13 weeks ended in February. But there was no meaningful detail on the B2B software product. The omission was glaring – and highlights the risk of baking a tech valuation into a stock that does not derive the bulk of its profits from it. “Every company claims they're a tech company now,” says Walter Price, fund manager at Allianz Technology Trust. “Not every company is a good tech company…Every company makes an investment, and they claim it’s going to make a difference. And the question is, does it show up in their revenue growth? Does it show up in their profitability?” 

The EV question

Electric vehicles or ‘EVs’ – especially autonomous ones – represent another shade of grey on the tech spectrum. In an interview with The New York Times, Apple’s Tim Cook aptly put it: “an autonomous car is a robot”.  

The marriage between hardware and software (famously one of Apple’s strengths) is what makes a high-quality, self-driving vehicle. It has been the key to Tesla’s (US:TSLA) success, where a tech-first strategy has placed its software miles ahead of its rivals in the auto industry. Unsurprisingly, that has caught the attention of Silicon Valley. It seems likely that Apple is developing a car, although it has avoided confirming media reports that it was in partnership discussions with carmakers, including Nissan (TYO:7201) and Hyundai (KRX:005380). 

But traditional players are starting to catch on, too. Volkswagen (GER:VW) plans to spend €35bn (£31bn) on battery EVs over the next five years and launch 70 all-electric models by 2030. In 2020, it sold the second-largest number of EVs behind Tesla.

Industry leaders like Volkswagen are slowly pivoting towards an EV-first strategy. If, as analysts predict, we are moving towards an electric, self-driving future, the market will have to take on a model that looks more like Tesla’s in order to survive. It is true that Elon Musk’s business will have a head-start in software development, but his competitors will need to reallocate resources into their own technology to stay competitive. 

Every car that has ever been created is, essentially, a big hunk of technology. The autonomous EV is its next evolution, and as it ripples across the industry we think that differentiating early movers as ‘tech’ businesses could lose its meaning very quickly.

An old need for new language 

We have not revealed any new thinking in these pages. Almost a decade ago, Alex Payne, a former code-writer who helped to create Twitter (US:TWTR), argued then that the definition of a “tech” start-up was getting too broad. “Many new companies...are, at the outset, leveraging technology for everything they do...This makes these businesses look like technology companies, if you squint. But, of course, they aren’t.”  

Rewind another 10 years, and sage investors exasperated at businesses flocking into the ‘dotcom’ craze, when it seemed any company with a website might change the world. 

We still have not solved the linguistic problem of marking a barrier between tech and tech-enabled companies, creators and utilisers. This is more critical than ever – the latter group is only getting bigger, as ‘digital transformation’ processes speed up in every corner of the market. 

Any company adapting to the realities of trading in 2021 will rely on tech in some way. Every industry is “using technology to disrupt its own business”, says de Gale. “Once one person does that, all their competitors have to copy it. So that new technology becomes a cost of doing business for all of them, rather than any competitive advantage for it now, it’s just what they spend money on.” 

This makes it difficult to map an outline of where the line between the sector and the rest of the market should lie. We think the most sensible approach, in the long run, is to carve out a ‘core tech’ group of businesses that generate the bulk of their profits through the sale of software and/or hardware. This too leaves room for interpretation, and not all companies will fit neatly within that category, as we have explored above. But we think it is worth narrowing the market’s definition in some form, if only to preserve the identity of an industry that has played such a long and crucial role in human innovation and preserve the capital of investors paying high prices for tech labels without the high-performance characteristics of true technology companies.